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No! Currency Wars Are Not Good!

Matthew O’Brien claims that competitive debasement is good for the global economy:

Currency wars get a bad rap. The trouble starts with that second word. Wars, as we all know, are very bad. And a currency war — where countries compete to lower their exchange rate to boost their exports — reminds people of the kind of trade protectionism that killed some economies in the 1930s. But currency wars are the best kind of war. Nobody dies. Everybody can profit. In fact, currency wars didn’t contribute to the Great Depression. They ended it.

The downside of devaluation is that no country gains a real trade advantage, and weaker currencies means the prices of commodities like oil shoot. But — and here’s the really important part — devaluing means printing money. There isn’t enough money in the world. That’s the simple and true reason why the global economy fell into crisis and has been so slow to recover. It’s also the simple and true reason why the Great Depression was so devastating. We know from the 1930s that such competitive devaluation can turn things around.

The world needs more money. Currency wars create money. It’s time for policymakers to forget the wrong lessons from history, get competitive, and start pushing down their currencies.

Since the last recession every major central bank in the world has fluffed up its balance sheet with purchases, pushing out new money into the system, and driving down exchange rates. So we already have a currency war.

The most obvious point is that the last thing the global geopolitical system — already knotted and twisted — needs is more strain, or more abrasions, and to some degree a currency war could strain relations. The biggest players in the developing world — China, Brazil, Argentina, India — are already experiencing elevated inflation. China and Russia and Brazil have all recently expressed deep unease at America’s policy.

Under such conditions, is it not reasonable to foresee that greater competitive debasement might lead to a full-blown trade war? An easy means for developing nations to stanch the decline in dollar-denominated holdings (FOREX, Treasuries, etc) would be to constrain the flow of dollars coming into their nations. How might that be done? Export quotas, and capital controls. I have long been of the view that the hyper-productive Eurasian nations do not “need” American consumption when they already have a big enough dollar hoard to recycle in domestic and regional consumption. America’s real economy is not being sustained by The Fed (that is sustaining the financial system), but rather by the ongoing free flow of goods and resources and energy from the developing nations to America. That’s the main reason why America spends so much money policing the world, to keep global trade flowing, and goods flowing into America. America consumes far more than she produces in terms of energy, in terms of finished goods, and in terms of components.

Simply, America has enjoyed a humungous free lunch on the back of the dollar’s reserve currency status. Nations throughout the world were willing to trade out their productivity, their resources and their energy for dollars, the international medium of exchange. America could sit back and diversify out of domestic productivity and into unproductive but nominally-higher-yielding financial services, consultancy, communications and entertainment. But dollars are no longer in such short supply; America has traded trillions and billions of them away. So some nations appear to be asking: Why do we need dollars? Why should we subsidise the Americans, when our own people go without? And of course, the Eurasian ASEAN bloc — and all the various new bilateral currency agreements, where Eurasian nations have agreed to ditch the dollar, and instead trade in their respective national currencies — is growing precisely to further this end, to diminish the American economic hegemony, and end the American free lunch. A series of currency wars could very easily be the thing that pushes the system into chaos.

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41 thoughts on “No! Currency Wars Are Not Good!”

Yes, currency wars are not good, but I don’t think they’re a choice to be made. It’s pretty much the default way the world works with free-floating currencies. All of the arguments I’ve heard against the euro, imply the idea that under normal circumstances (as opposed to the so called “failed euro experiment”) countries would always devalue their currencies to make up for lost productivity and because it’s somehow a more palatable way of greasing the wheels of a choked economy. AEP always points to Iceland saying it’s a proof that this always works. He doesn’t consider the idea that Iceland may be “sui generis” although he always points to countries that successfully devalued internally (Ireland, Estonia etc.) as being “sui generis”

“Yes, currency wars are part of how the world works. And so from time to time is systemic breakdown.”

Yes, but I don’t think savers all over the world will find this reassuring.

They’d rather have an easy means to save “money”, in a way that would preserve their purchasing power (and as we all know, you need to save before you can invest/start your own business). If I were in Brazil nowadays (a rather respectable country as of late, but with a dubious past with regard to inflation) I wouldn’t go to sleep comfortably with my savings in reals. How would I know if my country doesn’t decide tomorrow that the best solution for the country’s problem is a tiny hyperinflation spree?

You could say the obvious answer is gold, but the way gold is currently treated in the international monetary system does not necessarily mean it’s the safest way to store your money at all times because it doesn’t always follow the inflation rates (in USD terms, inflation-adjusted, gold lost 80% of its value in the last bear market 1980-2001; of course, if we were talking in rupees, gold only went up during all this time, but I digress).

And another thing: you could say “Oh, well, people will choose what’s safest for them as long as they have the liberty to do so”. But the problem is, gold was viewed as the safest asset in 1980, while Treasury bonds paying >20% yield per year for the next 30 years were viewed as “certificates of confiscation”. So unless you were some uber-contrarian-genius, gold was the place to be back then if you wanted to preserve your purchasing power. Of course, regular people are far from being geniuses when it comes to finance: they’d only want an easy means to preserve their purchasing power. So that’s why I’m saying the current system is far from perfect and (obsessed) guys like Ambrose Evans-Pritchard are fixated on the euro which prevents them from seeing the bigger problems with our monetary system.

No, gold is not in a bubble. It wasn’t in a bubble in 1973, either, but it still corrected by 40% then. I don’t believe gold is anywhere near a bubble phase. A bubble phase is characterized by the majority of market participants being involved in a market space. I saw a gold bubble in 1979–1980, when the whole world was dealing — buying and selling gold 24-hours a day, globally.

If you went to an investment conference in 1989, 90% of the people there would have told you they owned shares in Japanese companies. In 2000, 90% of them would have said they owned NASDAQ shares. Only about 5% of the participants at an investment conference today would tell you they own gold. Very few people in this world own gold.

The top comment:

That means treasuries and AAPL are in a bubble.

Easy. And the commenter will be proven right. Especially with all the wack-job wingnut “can you afford not to own treasuries and AAPL????” articles streaming out of the guts of the financial media.

It’s easy when you put it like this, but trust me that it’s not easy for the regular guy. Even Bill Bonner (who was already in the financial newsletter business) was tricked by this. He attributes his later acquired wisdom to the humbling effects of the 20 year bear market in gold.

And also, most importantly, sometimes “it’s different”; sometimes fear is there for a reason because the “system” is about to die.

If I’m not mistaken, this (above paragraph) is the view you’re currently espousing (i.e. in the past it was a smart decision to move in 1980 from gold to dollars but such a time might not ever come in the future – at least not w.r.t. the “current” dollar).

But most importantly, people (who aren’t even that rich to begin with) don’t want to wait for decades and 50% corrections and the like to reverse. They want an established way that would preserve their purchasing power “continuously”, without them having to wait decades and to become traders that understand trends and market psychology.

Andrew that is good insight. You are right, most peole just want something that grows above inflation. I don’t know about your country (Where is it?) But in Australia we have foced savings of 9% on top of our Salary (Employers pay the 9% into a Retirement fund instead of giving it to us) Many people watch their balances very closely. Cash, Shares Bonds (The terms used are safe-cash medium risk-mix of bonds shares and cash high risk-shares(International and local) with some cash)

I was talking obviously about the fact that “devaluing” the currency, setting interest rates and the like, are all decisions made by central planners.

PS: I wish there was a way to edit my comments. I don’t know if WordPress supports this, but maybe it might not be a bad idea to make the comments editable for 5 minutes after they have been posted (I know some platforms that support this).

Though, make sure that fame and celebrity will not corrupt you😛 (joking).

PS: It’s just the cynical me, but I put my faith in no one (not even in Tyler). I was positively unimpressed regarding Tyler’s attack on the not triggering of CDS (probably he gobbled up on some). Yes, changing the rules of the game might not be nice, and CDS while a valid idea should have been better regulated from the start. If not triggering CDS hurts pure speculators whose profit would only add more to the plight of some already suffering countries, then I’m all for not triggering them (I’m talking about hedge funds organizing to take positions in a very short amount of time to profit handsomely in advance of an announced plan).

Tyler was not very receptive of Taleb/Spitznagel’s debt-to-equity suggestion, although he seemed a little warmer to my corollary of convincing banks to do it voluntarily (I am adamant it would be beneficial in the long run).

I read this as him viewing contracts voluntarily entered into by parties as sacrosanct, which is a key tenet of libertarianism. Though maybe you should ask him why he takes the position he does.

My own take is that yes, contracts should be sacrosanct. But contracts entered into with sovereigns with a history of borrowing more they can afford to pay back should be entered into with a large slice of scepticism — scepticism that went missing with the advent of CDS. And of course, it was this neutered scepticism that spread all that toxic CDS sludge across the global balance sheet.

I don’t often praise George Soros, but Soros grasped the poisonous nature of derivatives before anybody else.

Yeah I saw the Zerohedge article, but the comments below put me to sleep. I really enjoy your blog Aziz.

I think you are right John. Most of the negative comments are from basement dwelling angry young men, who may have lost money on an ETF. I mean when I was younger I lost money in the Dot Com Boom. But we live and learn.

BTW I still don’t have access to Zerohedge. I will be using my real name and hopefully connecting to Australians who are intersted in joining the political party that I am developing (With an Economic Policy that I feel is more honest). I told them this and wrote to their Legal asking permission. They must be awfully busy with applications.

Yes, the quality of comments on Zero Hedge is sometimes less than thought provoking. In fact, Tyler has once or twice been openly (shall we say) questioning toward the intelligence of some of his own readers.

If every country debases it’s own currency by comparable amount it will just be another tax. Exchange rates won’t change and import/export will remain the same. It is just a transfer of wealth from people holding money and assets to the people with printing presses. How is this supposed to work?

Well, it works and it doesn’t. Some say that this is the best way for the world economy to function – with countries engaged in a perpetual currency war that plays out over months or years with each country taking its turn. At least, that’s what the high shaman priests of our global economy tell us. But don’t tell this to those suffering as a consequence, or to those countries that constantly blew up in hyperinflation.

Excellent point, Piotr. Our economic priests believe that the competition will spur economic feverish activity, leading to more and greater production.

The initial article (I hope readers read it and managed to hold back on the vomit) suggested that this is what got us out of the depression.

I have been over the data — including the data explicitly used by Eichengreen and Sachs — and I find it less than compelling. The key factor is productivity and accomplishments, and the absolute best you can say about devaluation is that sometimes, it greases the wheels a little. Maybe.

If I’m not mistaken, this (above paragraph) is the view you’re currently espousing (i.e. in the past it was a smart decision to move in 1980 from gold to dollars but such a time might not ever come in the future – at least not w.r.t. the “current” dollar).

For it to become a “good idea” to move into equities, a lot of fundamentals — would have to change. One of the most significant — and about the only thing I am even semi-bullish about — would be the U.S. foreign oil consumption percentage. It’s currently 45%, having been well above 50% earlier. If it dropped to say 25% or 30% that would be exciting. Levels of alternative energy consumption would get me excited too.

Another would be domestic manufacturing output. As Rick D’Angelo pointed out yesterday from 1967-77 we had a head and shoulders top in the SPX, and then it just bounced way higher on a massive surge in industrial output. I’m looking at 3-D printing to scale and deliver, and I would get excited about that.

Another would be a significant easing in barriers to entry and regulation (e.g. right to work) so that U6 can drop off. If U6 can really start to drop I will start to feel more optimistic.

Another thing I would get excited about are significantly lower consumer debt levels. And finally, perhaps the biggest thing to get excited about would be a broad commitment that America is going to ease off its role as world policeman. Obama has made some good promises in this regard, but I see no action.

I don’t really give a fuck about corporate profits, GDP, the DOW, NASDAQ, AAPL, all that manipulable shit that the Fed can print, and that slack-jawed Goldman Sachs alumni on CNBC get excited about. I am not a permabear, and in some ways I am a techno-optimist, but there are a few things about the global financial system (i.e. the fact that deflation under the present system is dangerous and leads to depressive spirals) that seem fundamentally broken.

Well yes, but by bringing all these concepts in you’re demonstrating that you need to be very financially conversant at times, and at various places, if you want to hope to even hold on to what little you got.

Basically, the problem I want solved is this: I want a means of saving money that would be guaranteed to preserve my purchasing power “continuously” and would be available to any man even if he’s not financially-adept. This would ease the uncertainty w.r.t. savings which would as a consequence spur investment.

I have no idea if this problem is solvable, but the closest thing that comes to something like this that I’ve seen, is FOFOA’s freegold – he sees physical gold as a global reserve currency that would have a relatively stable purchasing power (even if all gold production halted, or increased by 10% – just like the dollar serves as a reserve currency even in spite of QE programs or it being tied to US’s particular boom/bust cycles). But for getting to FOFOA’s view (if it is indeed workable – and it seems to me that it is) a lot of things need to happen: mainly physical gold needs to be freed from manipulation and needs to achieve the widest circulation possible (shows how stupid Buffett’s idea about owning all the gold in the world is).

PS: FOFOA sees (in addition to what I described above) that gold will also serve to regulate trade imbalances (due to its free-flowing nature, more explained on his blog) even though no currency in the world will be officially tied to gold.

Basically, the problem I want solved is this: I want a means of saving money that would be guaranteed to preserve my purchasing power “continuously” and would be available to any man even if he’s not financially-adept.

The problem, I think, is that this is quite paradoxical. I’d say FOFOA’s idea is the status quo with only a change in the worldwide mindset toward the concept of a reserve currency .

I think the compromise we are going toward in the short to medium term is one of fiat currencies with central banks and governments buying up more gold so as to preserve the currencies’ purchasing power. I still don’t believe this will work, but it could be better than the status quo. Maybe.

Here’s a report ZH posted a couple days ago that you might find interesting:

Well, a change in mindset is required alright, but his view is not the status quo because the dollar is still the reserve currency (and few, if any, world trade transactions are settled in gold). Otherwise, I don’t find it paradoxical at all, it’s actually the easiest path to follow when it comes to gold (certainly easier than a gold standard). I’ve seen that report and appreciate anyone’s honest hard work into investigating something, but I know enough to be able to say that anything can happen and will not use the report except as potentially a new piece in the puzzle of understanding the world and our future.

If I’m not mistaken, ZH kind of agrees with FOFOA. They said in a few posts something like: for them “the price of gold does not matter if you believe as we do that we’re moving to a barter system based on gold”.

Possible, because it means that they have fewer levers to control everything, but in a multi-polar world, it may be the best thing they can settle for.

PS: Someone may be wondering why wouldn’t someone, now, just keep his money in dollars and be done with it (since it’s the current reserve currency). And the problem is that not only its future is uncertain, but it has been decided through policy that it must lose its purchasing power even further (Fed’s PCE targeting which doesn’t even match the real higher inflation); the relatively stable freegold may fluctuate but at least it will not have been decided through policy that it must lose its purchasing power.

We’re dealing with a 50 year legacy of the various forms of Keynesianism (monetarism, DSGE, IS/LM, MMT, etc) being completely dominant in academia. The only place where the idea of taking delivery in gold is taking a root at a central bank level is China.

I’ll tell you something though: I think America will shift their productive base into Latin America before one ounce of gold leaves Fort Knox or the NY Fed. That may be the U.S.’s backup strategy the more uppity China gets.

We should remember Gresham’s law — if there’s any way for central bankers to pay in a paper derivative, they will find it.

Any opinions about the Australian economist and author of Debunking Economics Steve Keen? He suggests a systemic debt jubilee to prevent a global 20 year melt down de-levering of debt and possibly the rise of extreme politics of the far left and right. And his criticisms of neo classical and Keynsian economics are valid?